Taxes and the economy

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In the run-up to the Nov. 4 presidential election, the News Office has asked MIT experts to weigh in on the presidential candidates, their policy ideas and aspects of the campaign. In this installment in the series, Andrea Louise Campbell, the Hayes Career Development Associate Professor in the Department of Political Science, and James Poterba, the Mitsui Professor of Economics, look at economic issues and the proposed tax policies of the two presidential candidates.

Q: Both candidates have vowed to cut taxes. As indicated by the candidates' platforms posted on their respective web sites, what are the chief differences in the kind of taxes each candidate has vowed to cut?

Poterba: Sen. McCain has proposed increasing the exemption that taxpayers claim for dependents, reducing the corporate income tax rate (currently at 35 percent), and making permanent the personal income tax reductions that were enacted in 2001 and 2003, but that are scheduled to expire in 2010.Â The last proposal would fix the top personal income tax rate at 35 percent, which is the current rate, instead of 39.6 percent, the rate that prevailed prior to 2001.Â Sen. Obama has proposed preserving the current tax rates on single filers with less than $200,000 in Adjusted Gross Income (AGI), and on married joint filers with AGI below $250,000. Those with incomes above those levels would face tax increases as the current 33 percent tax bracket would rise to 36 percent, and the current 35 percent bracket would rise to 39.6 percent; the capital gains tax rate for these households would also increase. Sen. Obama also proposes a "Making Work Pay Credit" that would reduce taxes by up to $500 for individuals with wage income, and by up to $1,000 for married couples with two earners.

Q: Each accuses the other of raising taxes. Do you see any evidence that either candidate will raise taxes as indicated by their campaign statements online?

Campbell: The Tax Policy Center has calculated the impacts of these plans, and finds they have different fiscal and distributional implications. McCain's plan would reduce government revenues by $4 trillion over 10 years, or about 11 percent of total revenue current scheduled for collection. Obama's plan would reduce government revenues by $2.7 trillion, or 7 percent of currently scheduled collections (keeping in mind that there will be rising budget deficits for decades to come even if revenues aren't reduced). Most of the benefit of Obama's plan would redound to lower- and middle-income people while most of the benefit of McCain's plan would redound to very high-income people.

Poterba: Sen. Obama's tax proposal is explicit in suggesting higher income tax burdens on single persons with AGI of more than $200,000 and married couples with incomes above $250,000. It is also possible that these households would see an increase in their payroll taxes, the taxes that are used to finance Social Security and Medicare.

Q: Both candidates say they will stimulate the economy. What do you think are the best ways this could be accomplished and does either candidate address those issues?

Campbell: Studies show that the stimulative effect of increased spending on unemployment benefits and food stamps is greater (more return per dollar spent) than the stimulative effect of the tax rebates that were issued this spring. But such tax rebates certainly have their political allure. Democrats in Congress want another round of rebate checks; I'm not sure about Obama's stance on that. However, the current financial sector meltdown is of such enormous scale that it eclipses such stimulus packages. I think both candidates are grasping for appropriate policies (as are Bernanke, Paulson and the world's finance ministers).

Q: How do the candidates address the impact of federal entitlement programs (Social Security, Medicaid, Medicare) as the Baby Boomer population ages?

Poterba: Neither candidate has offered a fully articulated plan for addressing the prospective deficits associated with either Social Security or Medicare/Medicaid. Of the two, the deficits associated with health insurance programs for retirees are more daunting, because they are attributable to a combination of an aging population and the projected increase in the real cost of health care services. Achieving long-term fiscal balance in Medicare and Medicaid is going to be very difficult without slowing the growth of health care costs, but the political challenges of doing that are very substantial.

Campbell: Beyond the current financial crisis, these are the issues that will determine the fiscal future of the United States. For example, the Congressional Budget Office estimates that at current growth rates, health care -- currently 1/6 of the economy -- will constitute 100 percent of the economy in 2082, clearly an unsustainable trend. Social Security is a minor problem relative to Medicare. For Social Security, Obama proposes increased payroll taxes on those earning over $250,000, which in conjunction with a few other policy changes, would meet much of the 75-year projected deficit in promised benefits. McCain proposes supplementing the current system with individual accounts, but this does not address the long-term deficit in the program.

On Medicare, Obama proposes improving the prescription drug benefit, and "strengthening" and reducing waste in main program. McCain proposes to control Medicare's growth by reforming the Medicare payment system.

However, neither candidate really takes on this extremely difficult issue, the most important one we face. Both duck the huge growth rates in Medicare/Medicaid spending projected for the next several decades. And McCain's larger program of health care reform, which entails giving individuals and families tax credits to purchase insurance while eliminating the current tax deductibility of health care premiums for individuals and employers, is a truly radical reform that upends the health care system that has existed since World War II. Many analysts see a host of problems with this reform, which they fear will leave many without insurance (those who can't afford it because the tax credit is too small, those who will be denied coverage because of pre-existing conditions, etc.).